Business Context and Reporting Period
Flowserve Corporation filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2009. The company designs, manufactures, distributes and services pumps, valves, mechanical seals, automation products and aftermarket services for oil and gas, chemical, power generation, water management and other industrial markets. Operations are conducted through the Flowserve Pump Division, Flow Control Division and Flow Solutions Division, with approximately 15,000 employees in more than 55 countries.
Management reported some stabilization in business conditions during the second and third quarters of 2009, but demand remained weaker in mature markets, pricing pressure increased and customers delayed or reduced capital spending. The company had not experienced significant backlog cancellations.
Key Financial Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Sales | $1,051.1 million, down 8.9% | $3,166.2 million, down 4.2% |
| Gross profit | $385.2 million | $1,139.3 million |
| Gross margin | 36.6%, versus 35.1% | 36.0%, versus 35.4% |
| Operating income | $161.2 million, down 2.0% | $467.1 million, up 2.4% |
| Operating margin | 15.3%, versus 14.3% | 14.8%, versus 13.8% |
| Net earnings attributable to Flowserve | $116.9 million, versus $117.0 million | $317.5 million, versus $328.0 million |
| Diluted EPS | $2.07, versus $2.04 | $5.63, versus $5.68 |
| Effective tax rate | 26.5%, versus 18.6% | 27.2%, versus 23.6% |
Gross-margin improvement reflected favorable pricing on prior original-equipment orders, increased aftermarket mix, operating efficiencies and realignment savings. The higher tax rate primarily reflected favorable tax items in 2008 that did not recur. Other income was $7.0 million in the quarter, compared with $8.7 million of other expense in the prior-year quarter, mainly because of improved forward-currency-contract results.
Bookings, Backlog and Segments
- Third-quarter bookings were $975.3 million, down 29.0%; nine-month bookings were $2,946.0 million, down 28.4%. Declines reflected weaker oil and gas, chemical and general-industry demand, project delays, distributor destocking and the nonrecurrence of large 2008 orders.
- Backlog was $2,664.9 million at September 30, 2009, down 5.7% from December 31, 2008, including $35.4 million of cancellations. Currency translation increased reported backlog by approximately $90 million.
- Flowserve Pump Division third-quarter sales were approximately flat and operating income increased 9.3%; nine-month operating income increased 15.8%. Pump backlog was $2,088.5 million, down 7.3% from year-end.
- Flow Control Division third-quarter sales declined 19.6% and nine-month sales declined 13.8%; operating income declined 12.1% and 11.4%, respectively. Backlog increased 4.8% to $506.2 million.
- Flow Solutions Division third-quarter sales declined 20.2% and nine-month sales declined 14.3%; operating income declined 12.1% and 20.0%, respectively. Backlog declined 12.0% to $104.0 million.
Cash Flow, Liquidity and Debt
- Nine-month operating cash flow was $4.5 million, compared with cash used of $4.8 million in 2008. Working-capital movements, pension funding and reduced accrued liabilities constrained cash generation.
- Investing cash outflow was $117.8 million, including $87.1 million of capital expenditures and $30.8 million for the Calder AG acquisition. Management expected full-year 2009 capital expenditures of $100 million to $110 million.
- Financing cash outflow was $72.3 million, including $44.2 million of dividends, $27.5 million of share repurchases and $4.3 million of scheduled debt repayments.
- Cash and cash equivalents declined to $291.2 million from $472.1 million at December 31, 2008. Management cited incentive payments, capital expenditures, dividends, an $82.5 million U.S. pension contribution, share repurchases, working capital and the Calder acquisition as significant uses of cash.
- Total debt and capital lease obligations were $568.9 million, including $545.4 million of term debt. Current maturities were $27.8 million and long-term debt was $541.2 million.
- The company had no borrowings under its $400 million revolving credit facility and had $285.7 million of remaining borrowing capacity after $114.3 million of outstanding letters of credit. The term loan and revolver mature in August 2012; scheduled term-loan repayments were $1.4 million in each of the next four quarters.
- Approximately 71% of term debt was fixed-rate after interest-rate swaps. The European letter-of-credit facility was extended through November 9, 2009, and management was pursuing a replacement facility. Flowserve reported compliance with all debt covenants through September 30, 2009.
Management believed operating cash flow, existing cash and available revolver capacity would be sufficient for the next 12 months, while cautioning that economic conditions, customer credit, foreign exchange, interest rates and capital-market disruptions could adversely affect liquidity.
Material Changes, Outlook and Unusual Items
- Flowserve acquired Calder AG on April 21, 2009 for up to $44.1 million, net of cash acquired, to expand energy-recovery technology for desalination. The estimated contingent consideration liability was reduced from $4.4 million to $2.2 million in the third quarter, producing a gain in SG&A.
- The 2009 Realignment Program generated $33.2 million of charges through September 30, 2009 and was initially expected to generate approximately $60 million of annual savings upon completion. Management expected approximately $30 million of savings in 2009.
- Management planned additional realignment initiatives beginning in the fourth quarter of 2009 and continuing into 2010. These initiatives were expected to generate approximately $45 million of additional charges and approximately $50 million of additional annual savings.
- A $7.5 million third-quarter charge was recorded for increased fees and accrued resolution costs relating to a pending shareholder securities class action. Tentative settlement terms remained subject to unresolved contingencies.
- Management expected a full-year 2009 capital-expenditure range of $100 million to $110 million and stated that aftermarket activity, infrastructure investment, desalination, power, oil and gas and cost-reduction programs were important demand and margin drivers.
- Tax audits and the resolution of tax matters could reduce tax expense by an estimated $2 million to $29 million within the following 12 months, although the timing and outcome were uncertain.
Risks and Contingencies
- Bookings may not convert into sales at expected margins; customers may cancel or delay projects, particularly in oil and gas, chemical, power and other capital-intensive industries.
- Foreign exchange exposure is significant. The company had $342.8 million of forward-contract notional exposure, and estimated that a 10% currency movement could affect nine-month net earnings by approximately $32 million before considering forward contracts.
- Pending securities litigation could result in additional costs or materially adverse financial effects if settlement contingencies are not resolved or insurance is insufficient.
- Asbestos claims, the Republic of Iraq Oil-for-Food civil action and a potentially ongoing French investigation remain unresolved. The company also disclosed self-reported export-control violations and ongoing discussions with U.S. regulators; potential penalties could not be reliably estimated.
- Environmental remediation obligations, pension funding requirements, raw-material costs, project execution, supplier performance, debt-market access and counterparty performance could affect future results.
Important Facts for Investors to Verify
- Whether bookings and backlog stabilize or continue declining, and the extent of future cancellations and project delays.
- Whether the planned realignment charges, including the additional approximately $45 million, deliver the stated annual savings.
- Whether operating cash flow improves from the nine-month level of $4.5 million while funding pension contributions, capital expenditures, dividends and debt obligations.
- The renewal or replacement status of the European letter-of-credit facility after November 9, 2009.
- The final outcome and cash cost of the shareholder litigation, export-compliance matter, Oil-for-Food investigation and related proceedings.
- The sustainability of improved margins given lower demand, pricing pressure, currency volatility and fixed-cost absorption risk.